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Forward Misguidance

Listed author(s):
  • Luigi Paciello

    (EIEF)

  • Claudio Michelacci

    (EIEF)

A central bank announcement of a future reduction in interest rates (Forward Guidance) can be contractionary in the short run, when, as in the European data, the credibility of the central bank is higher among creditors than among debtors. When creditors believe the announcement more than debtors do, the wealth losses that creditors expect to incur are larger than the gains that debtors expect to realize and aggregate net wealth is perceived to fall. Forward Guidance announcements can then misguide the economy towards a contractionary period caused by lack of aggregate demand. This is more likely when financial imbalances are large and when the perceived credibility of the central bank differs substantially among creditors and debtors, as at the time of the ECB announcement in July 2013. By using micro data for Italian provinces, we find that more confidence in the ECB announcement was deflationary in a creditor province while it was inflationary in a debtor one, which is consistent with a misguidance effect. By using an heterogeneous agents sticky prices model calibrated to match micro data on financial imbalances and perceived credibility of the ECB, we find that the announcement was overall deflationary in the Euro Area.

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File URL: https://economicdynamics.org/meetpapers/2016/paper_617.pdf
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Paper provided by Society for Economic Dynamics in its series 2016 Meeting Papers with number 617.

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Date of creation: 2016
Handle: RePEc:red:sed016:617
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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